Cyprus: Looking Forward

Background

Cyprus is the third largest island in the Mediterranean Sea after Sicily and Sardinia, with a total area of 9.251 square kilometres (or 3.572 square miles). The island benefits from a strategic location in the north-east of the Mediterranean, and is effectively the ideal crossroads linking Europe, Africa and Asia as it sits in close proximity to these three continents and their trade routes.

The capital, Nicosia, the island’s administrative and main business centre, is situated in the central plain near the middle of the island.

Due to mild winters and long, dry summers (with an average of 300 sunny days per year), Cyprus enjoys one of the most pleasant and healthy climates in the Mediterranean. The population in the government-controlled area was estimated at 766,000 at the end of 2005.

Cyprus became an independent state in 1960, after 82 years of British rule, and is politically stable, with a system of government based on democracy; human rights, political pluralism and private property are safeguarded. Cyprus joined the European Union in May 2004, and is also a member of the United Nations and the Commonwealth.

Under the Constitution of 1960, the head of state is the President, who is elected by universal suffrage in a secret ballot. Cyprus has a multi-party system of democracy, based on proportional representation, whereby the President is the head of a council of ministers which carries on government, and prepares legislation. The House of Representatives is the legislature whose members are elected to office every five years by a system of proportional representation, with candidates from the various existing political parties and social groups.

Cyprus’ legal system has developed from its English counterpart and has retained the same principles, including those relating to banking, commercial and company law and procedures. Most statutes and regulations relevant to business practices are in the English language.

A system of administrative law governed by continental principles under the Constitution provides for the judicial review of public administrative decisions. The judiciary, which is independent from the other bodies of government, is modelled on the British system, consisting of the Supreme Court of the Republic, the assize courts, district courts, military court, industrial dispute court, rent control courts and family courts.

Currently, the official monetary unit is the Cyprus pound, divided into 100 cents. After Cyprus joined the European Union in May 2004, it linked its currency to the euro in the

European Exchange Rate Mechanism, and will switch to the euro currency on 1 January 2008. Cyprus is similar to most European countries in that it has an open economy dominated by private enterprise. Government intervention is largely limited to safeguarding the system, and providing guidance. By European standards, the economic growth rate has been high, averaging 5.1 per cent over the 1961-2003 period, along with full employment conditions, and internal and external macro-economic stability. A high proportion of GNP is based on tourism. Further, in July 2003, the Capital Movement Law was enacted and came into force on 1 May 2004, the date of Cyprus’ accession to the EU. This law repealed the Exchange Control Law, thus abolishing all exchange control restrictions.

Cyprus

Legal and Regulatory Framework

As of October 2004, Cyprus approved the complete freedom of direct investments from non-residents in Cyprus. Consequently, non-residents who wish to establish a company in Cyprus, who acquire shares in existing Cyprus companies, or who wish to invest in or from Cyprus, no longer require approval by the Central Bank of Cyprus. The same applies for direct and portfolio investments by natural or legal persons from EU member states.

At the same time, the government has long been vigilant against money laundering activities. The policy was formally put into effect by the Prevention and Suppression of Money Laundering Activities Laws, 1996. According to this legislation, banks and other persons engaged in financial business are required to implement watchful control systems for the detection of such activities. The central bank has issued a series of guidance notes to banks concerning strict customer identification procedures, record keeping, recognition and reporting of suspicious transactions, the appointment and duties of money laundering compliance officers, and the education and training of bank employees.

The types of corporate entities in Cyprus include companies limited by shares, branches of overseas companies, and general or limited partnerships. The most commonly used type of corporate entity is the company limited by shares. Since the central bank does not have to approve applications anymore, these are made directly to the department of the Registrar of Companies.

For companies limited by shares, the minimum number of directors is one. The directors may be natural persons or corporate, be of any nationality, and need not be resident in Cyprus. However, for tax residency purposes, they (or their majority) must be Cypriots.

The minimum number of shareholders is one.

A registered office is required, and it must be maintained in Cyprus. Companies carry on business activities in and outside Cyprus, have offices and/or have their administration in Cyprus, and have local and/or expatriate employees.

The procedure of incorporating a company involves submission of the memorandum and articles of association to the Registrar of Companies, together with an affidavit before a court (if the memorandum is to be submitted in English) and the registration fee. The powers and objects of a company in Cyprus are contained within the memorandum of association, and must be specific.

Disclosure of beneficial owners to the regulatory authorities is not required. It is possible to obtain absolute secrecy of the identity of shareholders, either through trust fiduciary agreements, through nominees, or through other companies. Business entities are required to prepare and submit to the Department of Finance and the Department of Inland Revenue annual financial statements audited by auditors practising on the island.

Tax Law

The House of Representatives of Cyprus approved a tax reform in July, 2002 (Law No. N118 (I) 2002), which has been effective since January 1, 2003. This tax reform aims to conform to the standards of the European Union and Its code of conduct, as well as abide by its commitment to the Organisation of Economic Co-operation and Development (OECD) to eliminate harmful tax practices.

As there is no longer a distinction between local companies and International Business Corporations (IBCs), the profits of all Cypriot companies will be taxed at the rate of 10

per cent. Existing IBCs that had income from their activities at 31 December, 2001 could choose to be taxed with the rate of 4.25 per cent until the end of the 2005 fiscal year. This regime makes Cyprus the country with the lowest corporation tax in the European Union. Dividend income from abroad and from Cyprus is wholly exempt from corporation tax. Profits earned from permanent establishments abroad are also fully exempt from corporation tax. As is common in most jurisdictions, companies that are involved in financial services to the public, especially banking, insurance and trust business, must get special permission from the authorities.

Cyprus has also signed double taxation treaties with several countries for the avoidance of double taxation of income earned in any of the two contracting states. It should be noted that Cyprus is one of the few countries in the world that has concluded tax treaties with all Eastern European countries. As a result of the recent liberalisation in Eastern Europe, the importance of these treaties in international tax planning has been enhanced.

Holding companies operating from Cyprus are also in a beneficial position because they can enjoy the benefits deriving from the tax exceptions, as well as the corporate tax benefits by virtue of the new tax legislation. Unlike other countries in Europe, a Cyprus holding company must only hold at least 1 per cent of the share capital of a foreign subsidiary in order to receive the tax benefits awarded by the new tax reform.

Trust Law

Cyprus’ trust law is essentially based on the English system. Trusts are mainly regulated by the Trustee Law, Chapter 193, enacted in 1955 and based on the English Trustees Act, 1925. This is supplemented by the English doctrine of equity and English case law prior to 1960.

In 1992, Cyprus enacted the International Trusts Law. This was done to update and modernise the law and establish Cyprus as an offshore financial centre and a serious trusts jurisdiction.

Essentially, trusts are divided into three main categories, namely Private Trusts, Constructive Trusts, and Charitable Trusts. Private Trusts are expressly created by the settlor, Constructive Trusts are imposed by law independently of what anyone intended, and Charitable Trusts are usually set up for certain public services, such as the relief of poverty or advancement of education.

Promising Outlook

With its strategic location, great accessibility, and excellent infrastructure, combined with the numerous government incentives, Cyprus is an ideal financial and business hub. Investments of European origin have to comply only with certain restrictions, such as respect for the environment and safety standards. With EU accession, dividends paid to

Cyprus from other EU countries have no tax withheld in those countries.

Besides the low corporate tax rates, the numerous double tax treaties that Cyprus has concluded with other countries (including with all Eastern European countries) offer tremendous possibilities for international tax planning through Cyprus. This is especially in view of the fact that any tax paid in a country with which Cyprus has a treaty is deducted from the Cyprus tax payable on the same income, and Cyprus does not impose any withholding tax on dividends, interest and royalties paid by business companies.